Are you compensating for illiquidity?

Listed infrastructure equities had a great year in 2010. By one measure, the Dow Jones Brookfield Global Infrastructure Composite Index – a broad benchmark of the performance of listed businesses in the port, airport, toll road and other sectors – returned 12.4 percent during the year. Adjust for the reinvestment of dividends, and you get an even more impressive 16.8 percent.

As with all investment classes, performance depends on the timeframe. Look at 2009 and 2008 and the return would undoubtedly look a lot less impressive. The global financial crisis was, at the end of the day, a liquidity crisis. Investors in need of liquidity sold securities – regardless of what they were.

That point hasn’t been lost on asset managers focused on the listed infrastructure space. Says Craig Noble, manager of a $7 billion portfolio of listed infrastructure equities at AMP Capital Brookfield: “The listed nature of what we’re doing means that [investor response] can happen from time to time”. At the end of the day, he points out, listed infrastructure is still a form of listed equity. So there will always be an element of correlation with the broader market.

“But the point is, the correlation is really low in most market conditions,” he says.

Indeed, Noble has published some insightful research that anyone crafting an infrastructure portfolio should take a look at. Noble analysed correlation data for listed infrastructure and the broader global equity market from 31 December 2001 to 31 December 2009. His analysis showed that, from January 2008 to December 2009, listed infrastructure showed a strong correlation to global equities of between 0.71 and 0.89. A score of 1.0 is a perfect positive correlation.

(It is important to point out that Noble’s universe is a very broad cross-section of listed utilities, master-limited partnerships, airports, toll road operators and other infrastructure businesses. He also looks at listed infrastructure funds, but that, he maintains, is a very small part of his overall listed universe – less than 5 percent).

The listed infrastructure space wasn’t alone in showing strong correlation. “The correlation of anything to anything that was liquid was very high, close to 1 in most cases,” Noble says. This is because investors needed liquidity.

But take a longer-term perspective and the same data shows that listed infrastructure generally doesn’t follow the broader equity market as closely as that. Noble’s analysis showed a correlation range between 0.45 and 0.60, suggesting that – contrary to what the financial crisis might lead you to believe – listed infrastructure can still provide diversification benefits to a portfolio.

This is important to unlisted infrastructure asset managers because the same argument is often applied to commitments to private infrastructure vehicles: invest in an unlisted fund, and you get diversification via access to a risk-return profile that’s not correlated to the broader market. The difference, clearly, is liquidity. Which, of course, makes one wonder: are unlisted managers giving investors enough of a premium for their illiquidity?

It’s a difficult question to answer in part because comprehensive data on unlisted infrastructure fund performance is still non-existent (this is, as we have pointed out before, one of the challenges facing the asset class). So perhaps it is better to phrase the question another way: are institutional investors demanding a premium for the illiquidity they agree to accept when they choose to access the asset class via the unlisted route?

Wrong benchmark

Apparently not. Exhibit number one is the puzzling core inflation plus 4 percent or 5 percent return that keeps popping up in pension documents in the US as an appropriate benchmark for unlisted fund performance. Past performance is never a perfect indicator of the future, but suffice to say that if you can more than double that by investing in listed infrastructure while preserving your liquidity, there is something clearly wrong with your benchmark.

“I’m very confident to say that, over the long term, we expect global listed infrastructure securities to have return profiles and attributes that are very similar to private infrastructure,” says AMP Brookfield’s Noble.

Which is why, as equity markets continue to normalise, it may be a good time to re-visit and adjust your expectations for unlisted infrastructure.